Proactive Budgeting to Drive Planning – April 2014

This topic involves budgeting.

As finance professionals become more involved in strategic duties, one area where they can be very helpful is budgeting and the use of forecasts (see our February 2014 piece on budgeting).  The increasing speed and complexity of business has reduced the typical process of annual budgets, quarterly forecasting, and monthly reporting to relics as an unsuitable management tool for many business enterprises.  Thus, many finance professionals see the need for a more proactive process.

A key characteristic of this transformation is the integration of the budgeting process with the firms strategic planning function.  An effective budget must have top executives set parameters, based on the CEO’s strategy, of what they want the firm to achieve.  From these parameters budget  targets are developed upon which operational mangers are to focus. In football, the game plan puts the coaches strategy to work.  Likewise, in business, the budget puts the CEO’s strategy to work.  As in football, business must adjust for unanticipated events that hinder the achievement of strategic goals.

This should result in an increase in scenario planning as part of the budget process.  By definition, this process should entail the prolific use of forecast data to guide strategic decisions.  Done correctly, this exercise can help develop contingency plans for “black swan” events on the downside and quick marshalling of resources for opportunities on the upside.

The marketplace has many ideas about the shift towards substituting dynamic forecasting for static budgets.  One is the use of a continuous rolling process whereby each month’s budget is updated to incorporate realities in the marketplace.  In this situation, the focus is on a revolving 12 month forward forecast.  The key objective is to enable critical quickness in reacting to changing economic or market conditions.  Hence, the budget is the initial goal, but it does not dictate the decision-making by management throughout the year.

A second idea is understanding the firm’s strategy and what is critical for success.  As a result, the budget needs a higher level of financial information on which to focus rather than general ledger level detail.  This enables management to focus on key drivers and not get caught up in minutia.  A good way to frame this approach is to work under the guideline that 80% of business outcomes can be expressed in 20 lines of detail.  Appendices can handle the rest.

In turn, finance professionals must develop metrics (financial and operational) to measure the degree of success achieved by implementation of the strategy.  These metrics do not just involve the outputs of the process, but also consider predictive measures further upstream in the business.  For example, did a poor selection of software vendors cause a surprise reduction in operating margins due to higher than expected costs.

Illuminating such important matters shows the importance of understanding the business’ key drivers so one can determine what is really happening.

For additional information, please see the following link:

http://www.journalofaccountancy.com/Issues/2014/Apr/forecasting-budgeting-cgma-magazine-20149480.htm

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